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The Importance of Cost Accounting in Financial Planning

Posted on October 1st, 2018

Jack Kern
Owner, President
Outsourced Accounting Department, Inc.

Can you point your car in the direction you want to go, step on the gas, and then sit back and wait to arrive at your destination?

Not quite. You can’t let your business run on autopilot either and expect good results. Any business owner knows you need to make numerous adjustments along the way – decisions about marketing, pricing, hiring, investments, and so on.

So, how do you handle the array of questions facing you?  A critical part of the decision-making process is financial planning, of which a major component is cost accounting.

Cost Accounting Helps You Make Informed Decisions

Cost accounting reports and determines the various costs associated with running your business. With cost accounting, you track the cost of all your business functions – raw materials, labor, inventory, and overhead, among others.

Note: Cost accounting differs from financial accounting because it’s only used internally, for decision making. Because financial accounting is employed to produce financial statements for external stakeholders, such as stockholders and the media, it must comply with generally accepted accounting principles (GAAP). Cost accounting does not.

Cost accounting allows you to understand the following:

  1. Cost behavior. For example, will the costs increase or stay the same if production of your product goes up?
  2. Appropriate prices for your goods or services. Once you understand cost behavior, you can tweak your pricing based on the current market. (Sample Price/Volume Analysis.)
  3. Budgeting. You can’t create an effective budget if you don’t know the real costs of the line items. (Sample Budget.)

Is It Hard?

To monitor your company’s costs with this method, you need to pay attention to the two types of costs in any business: fixed and variable.

Fixed costs don’t fluctuate with changes in production or sales. They include:

  • rent
  • insurance
  • dues and subscriptions
  • equipment leases
  • payments on loans
  • management salaries
  • advertising

Variable costs DO change with variations in production and sales. Variable costs include:

  • raw materials
  • hourly wages and commissions
  • utilities
  • inventory
  • office supplies
  • packaging, mailing, and shipping costs

Cost accounting is easier for smaller, less complicated businesses. In QuickBooks, you have the ability to perform “Job Costing,” which is a fairly simple method of associating the related costs to specific customer sales.  This is great for service based companies, or those buying and reselling a single product or products.  The trickier part is getting the costs and revenues into the same accounting period, which QuickBooks does not do FOR you.  At this point manual accounting adjustments are required.

If your product has component parts that make up the final product, you have “Inventory Assemblies” which is a quite a bit more involved in QuickBooks.

Either way, you first need to understand these costs before you can plan your business and make informed business decisions. The more complex your business model, the harder it becomes to assign proper values to all the facets of your company’s functioning. If you’d like to understand the ins and outs of your business better and create sound guidance for internal decision making, consider getting help from a financial professional to set up a cost accounting system that fits your business model.

Related Articles:

Strategic Financial Planning vs. Crisis Management

The Effect of Sales Growth on Cash Flow 

Case Study: The Risk of Sales Concentrations

 

 

 


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